University of ConnecticutOpenCommons@UConn

Honors Scholar Theses Honors Scholar Program

Spring 5-1-2018

The Tax Implications of Owning a ProfessionalSports FranchiseJeff Petersonjeffrey.g.peterson@uconn.edu

Follow this and additional works at: https://opencommons.uconn.edu/srhonors_theses

Recommended CitationPeterson, Jeff, "The Tax Implications of Owning a Professional Sports Franchise" (2018). Honors Scholar Theses. 582.https://opencommons.uconn.edu/srhonors_theses/582

The Tax Implications of Owning a Professional Sports Franchise

Jeff Peterson

April 23, 2018

Professor Schmeiser

Professor Dunbar

ACCT 4997W

Peterson 1

Contents The Tax Implications of Owning a Professional Sports Franchise ................................................ 0

I. Introduction ............................................................................................................................. 2

II. Ownership Structure .............................................................................................................. 2

A. Private Ownership .......................................................................................................... 3

B. Public Ownership ........................................................................................................... 4

C. Public Community Ownership ........................................................................................ 7

D. Single Entity Ownership ................................................................................................. 8

E. Summary ........................................................................................................................ 8

III. Downward Earnings Management ....................................................................................... 9

A. Why downward ............................................................................................................... 9

B. Managing GAAP and Tax Income Downward .............................................................. 10

IV. Income for Tax Purposes: The Roster Depreciation Allowance ........................................ 11

A. Early Developments in the Pre-RDA Era ..................................................................... 12

B. The Beginnings of the RDA .......................................................................................... 12

C. Issues with the RDA ..................................................................................................... 13

D. The Importance of Player Contracts ............................................................................. 14

E. Tax Law Changes in the 1970s .................................................................................... 15

V. The RDA Post-1976 ............................................................................................................ 16

A. The Omnibus Budget Reconciliation Act of 1993 ......................................................... 16

B. The Tax Reform Act of 2004 ........................................................................................ 16

C. Impact of the Tax Reform Act of 2004 .......................................................................... 17

D. Other Aspects of the RDA ............................................................................................ 18

VII. Future Developments for Tax and the RDA ...................................................................... 18

VIII. Conclusion ....................................................................................................................... 19

Peterson 2

I. Introduction

The sports franchise industry as a whole is in a great state of prosperity, evident by recent

activity such as American billionaire businessman and television personality Tilman Fertitta’s

purchase of the National Basketball Association’s (NBA) Houston Rockets for $2.2 billion.1 The

job of owner does not come without its own set of challenges as there are still daily

responsibilities and, depending on the market, the pressure is immense to put out a desirable

product for the fans. After all, a strong team performance leads to more ticket sales and

merchandising deals among other benefits like increased franchise value to the owners of the

franchise.

According to Forbes’s annual NBA team valuations, the league average for operating

income is equal to $52 million.2 Thus, the annual franchise income is unlikely to cover the initial

purchase price for decades. Based on Tilman Fertitta’s multi-billion-dollar purchase, if we

assume that the Houston Rockets brings in around $95 million in operating income before

interest, taxes, depreciation and amortization3 it would take Fertitta about 24 years to recover the

purchase price. There are other factors that affect the valuation, such as merchandising and

endorsement deals, and Fertitta has other ventures in addition to his NBA team ownership. The

decision to acquire a sports franchise in spite of the massive initial barrier to entry and marginal

returns may be a personal ambition, but this paper explores the possible tax savings aspect of the

transaction. These tax savings come about through a variety of factors, including ownership

structure and the related tax treatment of professional sports franchises.

II. Ownership Structure

To begin to consider the tax implications involved with sports ownership, the first major factor to

consider is the ownership structure. There are four different types of ownership structures found

throughout professional sports leagues each with their own sets of advantages and disadvantages.

These options include private ownership, public ownership through stock, public ownership

through the community, and single entity ownership. This paper explores the different types of

1 https://www.bloomberg.com/view/articles/2017-09-08/buy-a-sports-team-get-a-tax-break 2 https://www.forbes.com/sites/forbespr/2018/02/07/forbes-releases-20th-annual-nba-team-valuations/#53487b4034e6 3 https://www.forbes.com/teams/houston-rockets/

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issues associated with ownership structure as well as the reasoning behind one particular choice

of ownership structure over another relating to potential tax treatment.

A. Private Ownership

The first type of sports team ownership is private ownership. This method of ownership, whether

it be by individual investors or privately-held corporations, is by far the most popular method of

ownership across all of the major professional sports leagues. Among this list of ownership

structures also includes unincorporated partnerships made up by a handful of investors who act

as the shareholders.4

1. Advantages of Private Ownership

There are multiple advantages and benefits to this particular form of sports franchise ownership.

One of the main advantages is that private investors are often more suited for the task of sports

team ownership, whether that be due to their sources of capital, time available, managerial talent

available or past business experience. Along with this, the private investor group has a vested

interest in the financial success of the franchise because it is purely the main focus of their

business efforts. Because the ownership group is likely to be much smaller than the large number

of stakeholders that would be involved in a public ownership situation, private owners have

greater freedom to make decisions regarding the team’s operations. One of the biggest

advantages to private ownership, however, is having the ability to keep the company’s financial

statements private. This highly valued factor of private ownership means the owners can avoid

potential scrutiny from the public. They also do not have to worry as much about maintaining

investor confidence, as the financial statements are often important pieces of information that

investors use to make decisions. Private owners also do not have to worry about other investor

purchasing shares of their ownership stake because that is not an option under the private

ownership rules. Finally, some sports leagues, such as the MLB and NFL, favor private

ownership over public for reasons discussed in the public ownership section of this paper. In this

case the league rules either outright prohibit or otherwise strictly limit public ownership options.5

4 Smith, Brad (2003) “How Different Types of Ownership Structures Could Save Major League Baseball Teams from Contraction,” Journal of International Business and Law; Vol. 2: Iss. 1, Article 6 5 Ibid.

Peterson 4

2. Disadvantages of Private Ownership

The main disadvantage that exists in private ownership structures can often depend on the quality

of the ownership group. If the ownership group is profit-driven, they might only be interested in

actions that lower costs or raise revenue, such as raising ticket prices or cutting costs by paying

their players the least amount of compensation possible. This type of management behavior

could also lead to the owners being against other franchises entering into their immediate area as

they are afraid of losing fans to competing franchises. Overall, the community takes notice of

these actions and correctly realizes that such an extreme focus on the bottom line of a sports

franchises’ operations is certainly not healthy for the league.

Another disadvantage that exists under the private ownership structure is the difficulty of

raising funds for the team’s operations. A publicly owned franchise has many more options than

a privately-owned franchise when it comes to funding capital. For example, if the franchise

wanted to fund a new project such as a new stadium for the team, the publicly owned franchise

can just issue shares of stock to the public. Private owners do not have this option and often have

to use private funds for these ventures.

Finally, private owners do not have as easy of an “exit option” as public owners do.

Because the ownership is not in the form of publicly traded stock, the only option for private

owners to liquidate their investment is to make a direct sale with another investor. Liquidation

can be a difficult and time-consuming task, especially considering the rising prices of ownership

stakes in sports franchises. Also, all private owners and those who are in a partnership are

individually liable for the sports franchises’ debts depending on the type of partnership structure,

which can be a very large cost to have to pay for the investors.6

B. Public Ownership

Another type of ownership structure is public ownership. One of the most prominent examples of

this type of ownership structure is the Madison Square Garden Company. The company owns

sports franchises MSG Sports, which includes teams such as the New York Knicks of the NBA,

and the New York Rangers of the National Hockey League (NHL).7 The primary sources of the

revenue through their operations include ticket sales, distributions from television contracts,

6 Ibid. 7 http://investsnips.com/list-of-publicly-traded-sports-franchises/

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event-related revenue, local media rights, advertising and rental of suites.8 Direct operating

expenses include compensation expenses for players and team personnel, NBA luxury tax

payments, revenue sharing, event costs, venue leases and maintenance. This type of ownership

began in the 1990s when public companies mostly found in media, entertainment and

communications participated in sports team ownership through this method. It was mostly the

case when a media company owned multiple teams from different leagues in the same area. In

the case of the Madison Square Garden Company, the company also owns Madison Square

Garden, the arena where their sports franchises play their games.9 However, this is a trend that

has reversed over time since the companies involved in ownership have decided to divest of their

non-core assets, such as the sports franchises they owned, and questioned their ability to

maintain their role in team ownership.

1. Advantages of Public Ownership

One of the advantages of public ownership is easier fundraising through the issuance of stock.

Companies first go public to raise funds for their ongoing developments that they would finance

with equity rather than issuing debt. These funds could then be used for important purposes such

as paying players their signing bonuses and annual salaries, as well as providing a means to fund

construction of new stadiums.

Another desirable reason for public ownership is that it provides an “exit option” for team

owners. Because of the appreciating values of sports franchises, actual sales and purchases of

sports franchises are relatively rare, and investors could be forced to maintain their investment

for a longer time than they would wish. Giving owners the means to divest some of their

investment by selling their shares of stock in the franchise is an easy method of getting cash

value for their investments and adds flexibility with its liquidity.

Another reason that public owned franchises might be beneficial is that public companies

often have the resources, personnel, and funds required to enter into team ownership. A reason

that a public company might undergo this process is because it provides synergies with their

ongoing business model (e.g. Madison Square Broadcasting Company purchasing the rights to

the New York Knicks instead of buying the rising costs of broadcasting rights). Public ownership

8 Madison Square Garden Company. 2017 Form 10-K. Web. 18 April 2018. 9 Ibid.

Peterson 6

in general is good for sports leagues because teams owned by public corporations often have the

resources needed to be successful, which in turn makes the rest of the league more profitable due

to a sudden increase in franchise value and rules like revenue-sharing.10

2. Disadvantages of Public Ownership

There are also disadvantages to public team ownership. The sports leagues themselves often

implement policies that severely limit this type of ownership structure. For example, the MLB

has a rule that only allows 49% of a team to be distributed through stock in an IPO, and the

voting rights for publicly held shares are strictly limited. The National Football League (NFL) is

even stricter when it comes to public ownership, prohibiting corporate ownership entirely and

requiring league ownership approval of at least 75% in order for a transfer of ownership assets to

occur. Public offerings of shares are also prohibited in the NFL. The NFL contends that this

would provide an unfair competitive advantage for nonpublic company held teams due to a lack

of funds, as well as create a shift in focus from football to a rise in commercialization.11

Secondly, public companies are subject to new public disclosure requirements. Like all

publicly traded companies, a franchise which is publicly traded is subject to the rules and

regulations of government agencies such as the Securities and Exchange Commission; thus, they

would have to declare previously privately held information, such as sales, profits, executive

compensation, and certain key shareholder activities. In fact, most of the policies put in place by

the leagues that limit public ownership were established to prevent this kind of information from

being subject to public scrutiny by the media, government officials, or even players seeking a

contract with a team.12

Another potential issue with public ownership is the cost. In terms of time and finances,

issuing an IPO requires consulting with lawyers, accountants, and investment bankers. For

example, a $500,000 IPO could cost the owners upwards of $700,000 to fully implement, and

will appear as an ongoing expense on the disclosures given to the public.13 Another thing that is

important to consider when issuing an IPO is inspiring and maintaining investor confidence. An

IPO can only be considered successful if it is issued at a price that potential investors and

10 Ibid. 11 Ibid. 12 Ibid. 13 https://www.pwc.com/us/en/services/deals/library/cost-of-an-ipo.html

Peterson 7

shareholders will be willing to purchase them, which is a tough challenge for many publicly

traded companies. An IPO might fail because investors are more aware of business practices

used by these public companies, as well as the actual values of the teams that are owned by these

public companies. The publicly held companies have a hard time getting their shareholders a

reasonable return on their investment due to the appreciating value of franchises over time rather

than continual improvement demonstrated in quarterly and annual reports.

Finally, when a sports franchise goes public, the owners often lose some amount of

flexibility and control over the business due to the issuance of shares and the voting rights, which

adds to the risk of a hostile takeover.

C. Public Community Ownership

A unique type of ownership structure is public community ownership. The main factor that

separates this type of ownership from the standard public ownership is that the public owns the

majority of the stock, which in these instances is a majority interest of 70-75%. The remaining

25-30% is sold to a private management group or investor who actually operates the team and is

responsible for the team’s profits, expenses, and losses. Once this process is complete, the team’s

laws are modified to require a supermajority (¾) to approve of team relocation, effectively

keeping the team attached to its original city and fans. The actual process is done through a

market test, so if the public does not show any interest the team gets put back on the market and

is sold to a public or private investor instead.14

The most notable example of a sports franchise that utilizes this type of ownership

structure are the Green Bay Packers of the NFL. This unique situation exists because the Packers

ownership structure was grandfathered into the NFL around the same time that the NFL banned

community ownership from the league when they implemented their new revenue-sharing plan

in 1961.15

An interesting facet of this type of ownership is that there have been legal attempts to

promote its expansion and growth into professional sports leagues. These efforts include state

laws such as the New York Sports Fan Protection Act,16 which would create a State Sports

Authority that could condemn a franchise through eminent domain and sell shares of the team to

14 Ibid. 15 http://www.leagueoffans.org/2012/04/06/green-bay-packers-ownership-structure-remains-the-ideal/ 16 https://ilsr.org/rule/2787-2/

Peterson 8

the public if either the cost of its stadium exceeded the value of the franchise or if the owners

tried to relocate elsewhere. There have been multiple efforts on the federal level, including the

Give Fans a Chance Act of 201117 and the Fairness in Antitrust in National Sports (FANS) Act of

2001.18 The effective purpose of these acts was to prevent the league from outlawing community

ownership and help fans regarding possible elimination or relocation of local sports franchises.

D. Single Entity Ownership

The final type of ownership structure is single-entity. This option means that all of the teams in

the league are owned by a single entity, in most cases the league themselves. However, this

doesn’t really exist as a viable option in most scenarios because it would require the governing

body of the league, such as the MLB or NFL, purchasing all of the teams in a league from their

private owners. As such, this type of ownership structure would be best suited for a professional

sports league that is not as established as some of the major sports leagues, such as Major League

Soccer (MLS). Under this situation, the MLS is the sole employer of all of its players as opposed

to the individual private owners that we see in other professional sports leagues.

E. Summary

Most sports team owners only have one real option when it comes to ownership structure, which

is private ownership. Because the professional sports leagues generally have rules that prohibit

and/or strictly limit the ability of teams to undergo a public ownership structure, it is clear that

the leagues have a preference in regards to this matter. One of the main favorable factors to the

private ownership structure was that the owners have no legal obligation to disclose their

financial information to the public. This means that the owners do not have to disclose their

earnings and profits and do not have to worry as much about maintaining investor confidence,

which is an issue that other publicly owned companies deal with on a daily basis. Because the

owners do not have this issue, they can report losses to their investors at a greatly reduced risk,

which they can then use for their own tax benefit. The next section discusses why and how

owners may want to generate losses.

17 https://www.congress.gov/bill/112th-congress/house-bill/3344 18 https://www.congress.gov/bill/107th-congress/senate-bill/1704

Peterson 9

III. Downward Earnings Management

A. Why downward

Owners may want to manage earnings downward earnings for two reasons: 1. Minimize income

tax expense and 2. Increase negotiating power with unions. Because the majority of team

ownership groups are not publicly owned, the owners do not need to disclose their financial

information, making it difficult to detect earnings management.19

Professional sports owners have an incentive to use claims of financial distress to justify their

negotiating position in collective bargaining with the players. Financial experts and the players’

associations counter, saying that the owners are able to shelter their revenue streams by using

questionable methods.

As the two main parties involved in a professional sports league, the players and the owners

both engage in negotiations to reach more agreeable solutions to the league’s problems for both

sides.20 The focus of these debates is mainly centered around how the league revenue is split

between the owners and the players. The main focus of the players union during this process is to

get the most benefits for the players, including better pay and benefits. To counter this, the

owners will make their own arguments pointing to financial and economic distress which leads

to dropping profits and increased spending expenses, meaning they cannot bear the burden that

would come with giving the players more of their revenue.

Of course, for the owners to actually make this argument they must support it with evidence,

including financial information. Owners want to put themselves in the best position possible and

do so through these techniques. The public perception of the financial situation of the teams is

also important to manage. Portraying the team as being susceptible to financial distress could

help create at least some form of tolerance when it comes to tough financial decisions such as

raising ticket prices or concessions. This strategy could also help in other areas as well, such as

providing justification for a conservative strategy when it comes to using the team’s resources to

upgrade the team through free agency, lobbying for government subsidies when petitioning to

build a new stadium, or even as leverage when threatening to relocate.

19 Estes, Brent C. “Manipulating the Numbers: Earnings Management Techniques in Professional Sports,” Business Studies Journal; Volume 4, Special Issue, Number 1, 2012 20 http://www.jwj.org/collective-bargaining-101

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B. Managing GAAP and Tax Income Downward

Managing earnings downward occurs whether the team uses generally accepted accounting

principles (GAAP) or tax rules. Paul Beeston, former Vice President of the Toronto Blue Jays,

was once quoted saying, “Anyone who quotes baseball profits is missing the point. Under

generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss and

I could get every national accounting firm to agree with me.”21 It is impossible to know whether

or not the different sports franchises follow GAAP rules due to the nature of private ownership,

but the quote by Beeston still demonstrates how the RDA works for tax purposes as well.

A common technique for both is to “pay yourself first.” Simply put, the owners will pay

themselves a salary or get paid in fees by the team itself, which is an expense on the team’s

financials, thus reducing net income. This idea could also apply by using the team’s money to

purchase services from another company that is owned by the same ownership group.

Another type of earning management technique is to reallocate the revenues generated by

the team among other different entities also owned by the same ownership group. For example,

the ownership group not only owns the team, but also the stadium where the team plays. In this

case, they can allocate certain portions of the revenue to one group or the other, resulting in a

general decrease of overall earnings between the two entities.22

Finally, the tax on earnings can be manipulated by the choice of ownership structure of

the franchise. In the case of professional sports franchises, many owners have structured their

ownership in the form of a subchapter S corporation or partnership. Not only does this provide

certain tax advantages, but it also allows the income earned by the entity flows through directly

to the owners, avoiding entity taxation. For example, if a corporation reported a loss of $30

million and the shareholder had a 10% stake in ownership, the shareholder would be able to

claim a $3 million loss onto a personal tax return and offset other forms of income.23 If there was

any loss remaining after offsetting current year income it could be carried forward to the

following year as well, making this a very beneficial tax planning strategy.24

21 Keeney, Stephen R. The Roster Depreciation Allowance: How Major League Baseball Teams Turn Profits into Losses. The Baseball Research Journal Volume 45, Number 1 Spring 2016 22 Ibid. 23 https://www.thebalancesmb.com/business-losses-to-offset-income-397687 24 Ibid.

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IV. Income for Tax Purposes: The Roster Depreciation Allowance

Sports franchise owners are able to shelter taxable income through the Roster Depreciation

Allowance (RDA). The RDA has existed since 1946, when Bill Veeck convinced the IRS that

the roster of players on his newly acquired Cleveland Indians was a depreciable asset.25 When a

purchase of a sports franchise is made, the purchase price is allocated to the different assets that

were received in the transaction. Thus, if the purchase price allocation was mainly allocated to

player contracts, the owners could effectively amortize the actual purchase price of the sports

franchise, creating a large deduction that creates tax savings.

Throughout its existence, the RDA has been a controversial provision, and it has gone

through many different iterations during its existence. The amount that could be amortized as

well as the period over which the amortization could occur has changed, but the basic principles

behind the law have remained the same: the cost allocated to player contracts is amortizable.

The reason that the amortization is large enough to create significant tax savings is

mostly due to the nature of the initial purchase of a sports franchise. Sports franchises are made

up of assets and liabilities like any other business, but the majority of the value of the franchise

results from franchise rights. Essentially any right that comes with the unique position of owning

and operating a franchise in a professional sports league is included in this definition. These

franchise rights include rights to revenue-sharing as well as intellectual properties like

trademarks, trade names, and licenses. This asset also includes local broadcast rights, stadium

contracts, concession income, drafting players, and the services of players under contract.

Of course, different rights have different values, but the key is that they are intangible in

nature. Unlike other intangible assets which are traded on a marketplace such as stock or

physical tangible assets that have a fair market value such as equipment or machinery, the value

of these franchise rights is much more difficult to determine. Because of this, the allocation of

the purchase price is mostly up to the owners, and owners have an incentive to allocate as much

as possible to assets with a shorter useful life.

25 Veeck, B. and E. Linn. 1962. The Hustler’s Handbook. New York, NY: G.P. Putnam’s Sons.

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A. Early Developments in the Pre-RDA Era

There are two court cases from the 1920s relating to baseball teams and their treatment of player

contracts that predate the RDA. These cases are Chicago Nat’l League Ball Club v.

Commissioner26 and Commissioner v. Pittsburgh Athletic Co.27 The Pittsburgh Pirates and

Chicago Cubs of the MLB were using the difference between their player contracts that they

bought and sold during any given year as a deduction. However, both the Chicago Cubs and

Pittsburgh Pirates changed their practices in the late 1920s so that instead of deducting the

difference between the player contracts bought and sold, they took the entire amount spent on

player contracts during a given year and deducted the full amount. The teams argued that the

contracts effectively had a useful life of only one year and as such should be expensed in the year

that the expense is incurred instead of being amortized over time.

The IRS argued that under the reserve clause, a rule in baseball that gave all player

contracts a perpetual team options, a team could effectively retain their players for their entire

careers as long as they exercised the options each year.28 Therefore, the IRS argued that player

contracts amount should be deducted over a period of at least three years, the average length of a

player’s career during that time period. In both cases, the courts ruled in favor of the teams

because while the options did exist for their players, they did not account for the fact that a

player could choose to retire at any point in time during their contract. Also, the fact that the

option exists does not change the fact that the contracts really did have a one-year period of

enforcement. Because of this, player contracts did not really have an indefinite life as the IRS

argued.

B. The Beginnings of the RDA

In 1946, entrepreneur Bill Veeck bought the Cleveland Indians.29 Veeck, a businessman who

owned multiple baseball franchises over his lifetime, was the first individual to argue that player

contracts were depreciable assets. At the time, intangible assets were not subject to amortization

because they did not decline in value over a determinable amount, and even if they did it was

26 Chicago Nat’l League Ball Club v. Commissioner, 1933 WL 4911 (B.T.A.) (1933), affirmed sub nom Commissioner of Internal Revenue v. Chicago Nat’l League Ball Club, 74 F.2d 1010 (1935) 27 Commissioner of Internal Revenue v. Pittsburgh Athletic Co., 72 F.2d 883 (1934) 28 Ibid. 29 http://heathoops.com/2014/11/a-history-of-tax-sheltering-for-sports-team-ownership/

Peterson 13

even harder to determine the time period over which the value declined with reasonable

accuracy. Because the majority of the assets that were purchased with a sports franchise were

intangible, no amortization was claimed. However, there was one asset that was subject to

amortization - player contracts.

When a sports franchise is purchased it is necessary to allocate the purchase price among

all of the various assets and liabilities acquired in proportion to their fair market values. With no

rule in the tax law preventing the owners from assigning the majority of the purchase price of the

sports franchise to player contracts, Veeck argued that the amount of the purchase price allocated

to the player contracts should be treated as an amortizable asset.

C. Issues with the RDA

Buyers pursued a high allocation of initial purchase price for player contracts despite the fact that

the franchise rights were by far the more valuable of the two assets because they wanted as much

of their purchase to be depreciable as possible. The first major case demonstrating this issue was

seen in 1965 when the NFL expanded and welcomed the Atlanta Falcons as a new team.30 As a

part of this process the NFL held an expansion draft where the new owners chose from the

existing NFL team rosters and ended up with 42 players and contracts for their new franchise.

Then, when the new owners tried to depreciate both the cost of acquiring the players and the cost

of the franchise right of being an NFL franchise the IRS argued that the new owners were

allocating too much to the players and not enough to the franchise rights. There was also an

argument that the “mass asset rule” applied to the owners’ allocation.31 The mass asset rule

prevents the amortization of intangible assets of an indeterminate life if they can be tied together

with other intangibles of determinate life. In this case the franchise rights were the former and

the player contracts were the latter. The IRS felt this rule applied because they believed that it

was unreasonable to separate the costs of becoming an NFL franchise and the costs of acquiring

the players. The rule would also prevent the owners from dividing up the allocation between the

player contracts and the franchise rights and limit the amortization deduction. However, the court

disagreed with the IRS, ruling that the mass asset rule did not apply for two reasons: the player

contracts had a distinct value that was separate from the franchise rights and they also had a

30 “Atlanta Falcons Team Page,” NFL.com, http://www.nfl.comk/teams/atlantafalcons/profile?team=ATL 31 Laird v. U.S., 556 F. 2d. 1224, 1226-1230 (5th Cir. 1977)

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limited life that could be determined with an accurate value.32 This decision resulted in the

continued practice of separating and amortizing player contracts and franchise rights.

As another part of the ruling, it was also determined that franchise rights such as

television revenue rights were not depreciable due to the nature of their indeterminate life, which

lasted as long as the franchise is a part of the NFL. Therefore, owners got the most benefit from

allocating as much of their purchase price to player contracts as possible, which they would

continue to do going forward.

D. The Importance of Player Contracts

A player’s contract outlines the amount of compensation that will be paid to the player as well as

the necessary things that need to be done to earn that compensation. The contracts also state over

how many years it applies and includes other things like signing bonuses and other options. The

rights to a player’s contract, on the other hand, relate to the ability to enforce the contract and

making sure that the player it applies to will abide by its ruling.

A practice that existed early on in the history of American sports but has since been

phased out is the buying and selling of the rights to a player’s contract. The value of these rights

was determined by looking at the amount of potential revenue that a player would bring in to the

franchise and comparing it to the average salary of the player. For example, if a player had a $5

million annual salary and was expected to bring in revenue of $7 million, an opposing franchise

might be willing to pay $1 million for the rights to that player’s contract. In this way, the $7

million in revenue minus the $5 million in salary and the $1 million purchase price of the

player’s contract would leave a net total of $1 million in revenue to be gained by the franchise.33

If another player had the same amount of salary but was projected to bring in much more

revenue, another franchise would be willing to pay much more for the rights to that player’s

contract. These rights to player contracts were represented by the player contracts asset when

purchasing a sports franchise.

Thus, it was important to determine how valuable the player contracts are to the

franchise. The greater the portion of the overall purchase price is determined to be allocated to

player contracts and rights, the greater amount that needs to be amortized, and the larger tax

32 Ibid. 33 https://sportslaw.uslegal.com/sports-agents-and-contracts/sports-contracts-basic-principles/

Peterson 15

deduction that results. For example, in 1970, Bud Selig, who would go on to become the

commissioner of the MLB, purchased the Seattle Pilots for $10.8 million. Of that $10.8 million,

$10.2 million (or about 94%) was allocated to the purchase of player contracts.34 This amount

was allocated this way despite the fact that the contracts themselves were only worth about

$607,400.35 The proposed allocation was upheld in court. Congress acted to prevent these types

of allocations in the future,36 but it still serves to help understand how important player contracts

are and how they work within the scope of the RDA.

E. Tax Law Changes in the 1970s

The constant battle of proper allocation between franchise rights and player contracts came to a

head in 1970 when Bud Selig purchased the Seattle Pilots. The announcement of Selig’s

proposed allocation is what caused Congress to take action on this issue and take the first steps

necessary to prevent these kinds of allocations in the future.

Congress enacted Section 1056 as part of the Tax Reform Act of 1976, which helped to

regulate the tax treatment of player contracts.37 Subsections (a)-(c) dealt with basis, but the main

focus for the purposes of allocation was in subsection (d).38 This subsection created a

presumption that the purchase price of a sports franchise could not be allocated to player

contracts in an amount greater than 50% of the total purchase price. It could exceed 50%,

however, if the owners could establish that the proposed allocation was reasonable in nature. The

amount related to player contracts could then be amortized over a five-year span rather than over

the life of each individual contract. After the five years were up the player contracts asset would

be fully used up and the depreciation deduction would no longer exist. The law was known as the

50/5 rule, which streamlined the process of the allocation and created one depreciable asset on

the sports franchises’ books for all of the franchises’ contracts. However, it did not entirely act as

a general rule for purchase price allocation as it was only written into law as a presumption. As a

result, many franchise owners continued to go to the IRS seeking to allocate as much purchase

price as possible into player contracts. Because the IRS believed that franchise rights were not

34 Selig v. U.S., 740 F. 2d. 572, 574 (7th Cir. 1984) 35 “1969 Seattle Pilots Roster,” Baseball-Almanac.com, http://www.baseball-almanac.com/teamstats/roster.php?y=1969&t=SE1. 36 Ibid. 37 26 U.S.C. § 1056 38 https://www.govtrack.us/congress/bills/94/hr10612/text

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amortizable because they did not have a determinable life and that player contracts were

amortizable due to their easy to determine useful life (only being valuable for however many

years the contract applied to the player), buyers decided to allocate as much of the purchase price

of the franchise to player contracts as they could.39

V. The RDA Post-1976

The rules that were created as a result of the Tax Reform Act of 1976 persisted until

Congress made some changes related to the RDA, as well as the general tax treatment of

professional sports franchises, in 2004. During this time frame there were also major changes

made which further changed how the RDA would behave going forward.

A. The Omnibus Budget Reconciliation Act of 1993

Leading up to the 2004 change, there was a law passed by Congress in 1993 under Section 197

as part of the Omnibus Budget Reconciliation Act of 1993.40 Section 197 changed the tax

treatment of intangible assets, making it so that all intangible assets that were purchased in an

acquisition could be amortized, and would be done so over a 15-year period. This was known as

the 100/15 rule.

There was one industry which was excluded from this new treatment, which was the

sports franchise industry. As a result, the RDA continued to exist and the 50/5 rule would

continue to apply as a result of the exclusion of the sports franchise industry from Section 197.

B. The Tax Reform Act of 2004

Section 1056 persisted until 2004 when the Tax Reform Act of 200441 was passed. The

ruling would repeal Section 1056, which is what originally defined and established the proper tax

treatment of player contracts in the 1970s and created the 50/5 rule. As a result of the repeal,

Congress allowed sports franchises to receive the same treatment that all other industries were

subject to related to the amortization of intangible assets under Section 197. Congress allowed

this because under Section 197 the amortizable deduction for intangible assets was allowed for

“workforce in place” (equivalent to the player contracts asset) and “any franchise, trademark, or

39 Ibid. 40 https://www.congress.gov/bill/103rd-congress/house-bill/2264 41 https://www.congress.gov/108/plaws/publ357/PLAW-108publ357.pdf

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trade name”.42 Other reasons for allowing sports franchises to be applied under this ruling

include making the law more uniform across all industries and cutting the costs of administration

and enforcement to the IRS when it came to allocation disputes. There was also an argument that

the overall tax revenue would actually increase as a result of the ruling. Although the actual

amount of the deduction increased from 50% to 100%, the amortization period tripled from five

years to fifteen years. This means that although more of the intangible assets were depreciated,

they were also being depreciated over a significantly longer period of time. As a result, owners

would be depreciating a much smaller amount each year and be taking a smaller deduction when

it came to filing their income taxes, leading to more of the tax revenue being collected in the

short term than under the previous ruling.43

C. Impact of the Tax Reform Act of 2004

Once the specific exclusion of sports franchises was repealed, owners were now subject

to the 100/15 rule, meaning that nearly all of the purchase price of these franchises was fully

amortizable over a fifteen-year period. This was only the case when the allocation of the

purchase price was significantly in favor of intangible assets since tangible assets did not fall

under the same rulings allowed under Section 197. During the allocation of the purchase price,

an amortizable deduction was created that flowed through to the partners/shareholders and their

income tax returns. One thing that had not changed throughout the history of tax rulings related

to professional sports was that the vast majority of what is purchased when acquiring a

professional sports franchise is intangible. The kind of assets that are tangible, including

equipment and facilities, are often so minor when compared to the overall purchase price of the

entire sports franchise that it makes sense to allocate most of the purchase price to the intangible

assets anyway. With the end result of the ruling being more tax revenue could be recognized in

the short term, the new changes had their desired effect and finally helped to limit the tax

deductions that were taken by professional sports franchise owners.44

42 26 U.S.C. § 197(d)(1)(C)(i) 43 Ibid. 44 Ibid.

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D. Other Aspects of the RDA

There are some other factors that need to be considered when looking at the overall

effects of the RDA. One of these factors is that the actual tax deduction that is taken each year is

only temporary. The amount that is taken as a deduction in each tax year will eventually be paid

to the IRS when the franchise is sold and the owners likely report a gain on the sale due to the

depreciation of the franchise and its assets. In this way, while the RDA does not affect the total

amount of tax dollars that are paid by a sports franchise to the IRS, it does have its uses when it

comes to other tax planning strategies. One of these uses is that it allows for more revenue to go

by untaxed due to the increase from 50% to 100% of intangible assets being depreciated.

Another is that it allows the owners to have lower revenue numbers on their income

statement. While this revenue will eventually be paid back, the tax breaks created by the RDA

help to create what is essentially a deferred tax liability because the tactics allow the owners to

defer paying their taxes until a later date in the future. In this way the RDA almost acts like an

interest-free loan from the government, but with the owners are also generating income from the

operations of the sports franchise they are still realizing a net benefit overall.

Finally, it is interesting to consider that while the ruling is known as the Roster

Depreciation Allowance, the main focus is with intangible assets, which are subject to

amortization rather than depreciation. Amortization and depreciation are effectively the same,

but the naming convention is a result of Section 197, which governs the treatment of intangibles,

not being enacted until 1993 under the Omnibus Budget Reconciliation Act. Therefore, during

the time that the RDA was enacted into law, amortization was a less common principle and

depreciation was used to define the tax treatment of player contracts.

VII. Future Developments for Tax and the RDA

Since the passage of the Tax Reform Act of 2004 there has not been much change

regarding the tax treatment of professional sports franchises. But with the passage of the new

Tax Cuts and Jobs Act (TCJA) in late 2017, it is possible that change is on the horizon for the

sports franchise industry.45 While the current law does not change the status quo for sports

franchises, the fact that major tax changes are underway means that it is always a possibility for

45 https://www.lbmc.com/blog/us-tax-reform-summary-of-the-tax-cuts-and-jobs-act

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some changes to occur in the future. The current effects of the TCJA are yet to be seen, but there

are some major takeaways from the new law. The focus of the new ruling is mainly seen in the

operations of corporations and individual tax treatment. There has been an overall cut of income

tax rates for both parties, including a drop from a 35% rate to a flat 21% rate for corporations.

On the other hand, the top individual rate has dropped from 39.5% to 37%. Other changes

include the doubling of the standard deduction and the elimination of personal exemptions.

Lastly, the changes being made for corporations are permanent while the individual changes will

eventually phase out at the end of 2025.46 In terms of the main rule that impacts sports franchise

owners, Section 197, the TCJA doesn’t add anything new or change any existing terms. The law

remains unchanged and owners can continue to use creative accounting techniques to use the

RDA to their tax advantage.

VIII. Conclusion

The RDA is a unique aspect of professional sports franchise ownership which allows for

deductions and tax savings that are very beneficial to sports franchise owners. It cannot be

denied that as long as the RDA remains a commonplace practice in professional sports

accounting it will be a prevalent aspect of the industry. This could remain a vital area of the

industry for many years to come, especially considering the lack of action related to Section 197

in the recent Tax Cuts and Jobs Act. On the other hand, as long as creative accounting techniques

remain a hot buzz issue in the accounting profession, the RDA is likely to be scrutinized and

analyzed for its validity and legitimacy for many years to come. Whether or not the analysis

results in any significant changes to the RDA will remain to be seen.

Ever since its inception back in the 1940s the RDA has caused problems for Congress

and it has gone through a significant amount of changes, so change in the future is a definite

possibility. While the average sports fan probably is not interested in how their teams’ owners

file their income tax returns, they are definitely invested in seeing their team perform well.

Having the ability to spend money and invest capital into the franchise is key, so avoiding paying

taxes now to reinvest into the franchise could very well pay dividends in the future when the

46 Ibid.

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team is successful and bringing in more revenue. As long as something like the RDA helps the

team to remain competitive in a cutthroat industry, expect it to remain for the foreseeable future.